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The Dynamics of Informality and Fiscal Policy under Sovereign Risk

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  • Francesco PappadÃ
  • Yanos Zylberberg

Abstract

This paper examines how the dynamics of informality affects optimal fiscal policy and default risk. We build a model of sovereign debt with limited commitment and informality to assess the consequences of dynamic distortions induced by fiscal policy. In the model, fiscal policy has a persistent impact on taxable activity, which affects future fiscal revenues and thus default risk. The interaction of tax distortions and limited commitment strongly constrains the dynamics of optimal fiscal policy and leads to (i) more frequent default episodes and (ii) costly fluctuations in consumption.

Suggested Citation

  • Francesco Pappadà & Yanos Zylberberg, 2025. "The Dynamics of Informality and Fiscal Policy under Sovereign Risk," Bristol Economics Discussion Papers 25/795, School of Economics, University of Bristol, UK.
    • Handle: RePEc:bri:uobdis:25/795
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